Blog Post

Unpacking the Administration’s Revised Social Cost of Carbon

Oct 10, 2017 | Richard G. Newell

The Trump administration’s announcement on plans for moving forward with the repeal of the Clean Power Plan obviously reaffirms its position that the Obama administration’s approach on climate was too aggressive. It is therefore important to assess the administration’s arguments for why the Clean Power Plan represented federal overreach. There are some interesting nuances.

First, the administration has accepted the reality that regulating the emission of greenhouse gases is required under the law. Absent a new decision by the Supreme Court or changes to the Clean Air Act, federal climate policy is a reality. The debate now centers on how far to go and how to get there—including with respect to the benefits and costs of different approaches. This context also frames ongoing activity at the state and regional level, as well as steps being taken by the private sector.

From an economic perspective, a major thrust is that the Obama administration overestimated the Clean Power Plan’s benefits, by using a value for the social cost of carbon (SCC) that is too high. Specifically, the regulatory impact analysis accompanying the proposed rule implies that Obama-era regulators erred in using too low a discount rate (which gives greater weight to benefits in the future) and mistakenly including non-US benefits in its calculation.

As an economist, I understand the important role that benefit-cost analysis plays as part of the decisionmaking process for such an important policy decision. And as co-chair of a recent National Academies of Sciences, Engineering, and Medicine (NAS) committee that looked at ways to improve estimates of the SCC, the administration’s arguments reinforce the practical importance of continued work on this topic. The NAS committee recommended a framework, a set of criteria, a policy process, and a research agenda for enabling the SCC to reflect the best available scientific evidence and methods over time. Understanding that science continues to evolve in this area, the committee put forward this framework in the spirit of continuous improvement, grounded in a thorough and predictable process.

Rather than move forward with the comprehensive near-term recommendations of the National Academies, however, the administration has chosen to narrowly change two particular aspects of the methodology, with resulting revised 2020 values for the SCC of $6 or $1 per ton, depending on the discount rate (3 percent and 7 percent, respectively). These revisions represent a dramatic downward reduction of 87 percent to 97 percent from the previous central value of $45 per ton for 2020 (all figures in 2011 dollars).

There are clear grounds to question the administration’s reasoning for its choice of a new SCC. The issues here are very technical, but have profound implications for US climate policy. In fact, the range of discount rates used is not appropriate under standard economics, leading to much weaker policy than would otherwise be the case.

One very important change the administration has made to generate the new SCC estimates is the inclusion of a much higher 7 percent discount rate in their analysis. Though the addition of an estimate calculated using a 7 percent discount rate is consistent with past regulatory guidance under OMB circular A-4, there are good reasons to think that such a high discount rate is inappropriate for use in estimating the SCC.  

From a purely practical standpoint, the models used to generate the SCC estimates report their output in terms of what are called “consumption-equivalent” impacts, which is intended to reflect the effective impact on people’s consumption. Standard economic practice is to discount consumption equivalents at the “consumption rate of interest”, which according to OMB’s current guidance is a 3 percent discount rate.

It is clearly inappropriate, therefore, to use such modeling results with OMB’s 7 percent discount rate, which is intended to represent the historical before-tax return on private capital. None of the researchers whose model results were used employs a discount rate as high as 7 percent in their work. This is a case where unconsidered adherence to the letter of OMB’s simplified discounting approach yields results that are inconsistent with and ungrounded from good economics. Practically speaking, the use of such a high discount rate means that the effects of our actions on future generations are largely unaccounted for in the new analysis. This is incompatible with the long-lived nature of greenhouse gas emissions in the atmosphere, and the fact that damages from emissions today will continue to be felt for generations to come. Moreover, a recent report from the Council of Economic Advisors found that evidence supports a rate lower than 3 percent as the norm for the consumption rate of discount, which it suggested should be at most 2 percent given historical trends and expected future conditions.

Similarly, choosing to count only direct domestic US benefits from carbon mitigation is consistent with a narrow application of prior regulatory analysis practice, but is unnecessarily constrained and unwise for addressing inherently global pollutants like greenhouse gases. Damages from US emissions of greenhouse gases are felt not just within US borders, but also abroad. Though such damages occur on foreign soil, their economic effects can be felt here at home through the globally interconnected economy. Regulatory actions taken by the United States also may be reflected in policy actions taken by other countries, with perhaps the clearest example being the Canadian government’s full incorporation of the prior US federal value for the SCC in its own regulatory analysis.

This set of complicated global interactions are a challenging, but important, component of any complete calculation of damages felt by US citizens from domestic emissions, but they are wholly omitted in the administration’s revised methodology.

The issues raised by this interim revision of the SCC are by no means settled, and represent only a few of the many questions that need to be resolved on our way to greater consensus and confidence in the SCC. Given the importance of SCC as a tool in regulatory analysis and other decisions, RFF is leading a multi-year, multidisciplinary research initiative to answer these questions and implement the full set of near-term recommendations of the NAS to update the methodology for calculating the SCC, enhance transparency, and ensure that the estimates reflect the best available science. The new initiative will lead to a comprehensive update of estimates of the social cost of carbon, as well as facilitate a more flexible and regular process for updating the estimates going forward. These improvements will enhance the capabilities of decisionmakers and analysts worldwide who use the social cost of carbon to measure the benefits of emissions reductions, now and in the future.

The views expressed in RFF blog posts are those of the authors and should not be attributed to Resources for the Future.